The #HanjinShipping demise for dummies [economists]

The insolvency of Hanjin Shipping reflects a new low in the troubled waters of container shipping. It is part of a longer story, with complex impacts. But what are the fundamental underlying causes? Here are three simple [economist’s] explanations.

#1: Less demand than expected

It takes time to plan, order and build ships. When today’s container ship fleet was on the drawing tables, everybody expected maritime trade to grow faster than it effectively did. GDP growth slowed down, and on top of that, the trade/gdp coefficient today is smaller than in earlier decades. As a result, the demand curve is more to the left than what ship owners assumed when they constructed today’s capacity.

It’s a game. In order to reduce their unit costs, ship owners invest in new, bigger and more fuel efficient ships. The problem is that the older capacity is not scrapped. The vessel stays on the market (sold, or returned to the charter owner), leading to an expanded capacity limit. The short term supply curve moves to the right.

#3: Technological change

Last but not least, probably the most important development is technological change. With higher fixed costs (today’s mega container ships cost about $150 million each), against lower variable costs (less fuel, communication and crewing costs per container), the short term supply curve becomes steeper. The same change in demand leads to a higher change in the freight rate.

Charter and freight rates become more volatile.

As long as a carrier can cover his variable costs, he will continue to bend down further and further, and offer his services below his long term average costs.

# 1, 2 + 3: The short term has been with us for too long

The typical shipping cycle over the last two centuries lasted between 3.5 and 7 years. For more than a decade now, however, container ships have kept growing in size, which has encouraged ship owners to continue their investments in ever bigger new ships for too long. The ever steeper short term supply curve has led to unsustainable low and volatile freight rates. Until we reach a plateau in vessel sizes, be ready for more cases like Hanjing Shipping.